ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SELECTED FINANCIAL DATA
The following data should be read in conjunction with the unaudited consolidated financial statements and management’s discussion and analysis that follows:
|
|
As of or for the three months ended September 30, |
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|
As of or for the nine months ended September 30, |
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|
|
2022 |
|
|
2021 |
|
|
2022 |
|
|
2021 |
|
SIGNIFICANT RATIOS (Unaudited) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income to: |
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average assets (a) |
|
|
1.15 |
% |
|
|
1.54 |
% |
|
|
0.96 |
% |
|
|
1.39 |
% |
Average tangible shareholders’ equity (non-GAAP) (a) |
|
|
20.33 |
% |
|
|
18.59 |
% |
|
|
14.90 |
% |
|
|
17.03 |
% |
Net interest margin (a) |
|
|
3.91 |
% |
|
|
4.12 |
% |
|
|
3.65 |
% |
|
|
3.84 |
% |
Efficiency ratio (a) |
|
|
71.42 |
% |
|
|
65.33 |
% |
|
|
73.62 |
% |
|
|
66.68 |
% |
Average shareholders’ equity to average assets |
|
|
8.34 |
% |
|
|
11.05 |
% |
|
|
9.18 |
% |
|
|
11.02 |
% |
Loans to deposits (end of period) |
|
|
66.35 |
% |
|
|
63.58 |
% |
|
|
66.35 |
% |
|
|
63.58 |
% |
Allowance for loan losses to loans (end of period) |
|
|
1.63 |
% |
|
|
1.75 |
% |
|
|
1.63 |
% |
|
|
1.75 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Book value per share |
|
$ |
22.79 |
|
|
$ |
35.46 |
|
|
$ |
22.79 |
|
|
$ |
35.46 |
|
Tangible book value per share (a) |
|
$ |
13.83 |
|
|
$ |
26.56 |
|
|
$ |
13.83 |
|
|
$ |
26.56 |
|
(a) |
Some of the financial measures included in this table are not measures of financial performance recognized by U.S. Generally Accepted Accounting Principles, or GAAP. These non-GAAP financial measures include tangible book value, return on average tangible equity, net interest margin (tax-equivalent), and the efficiency ratio. Management uses these non-GAAP financial measures in its analysis of its performance, and believes financial analysts and investors frequently use these measures, and other similar measures, to evaluate capital adequacy. Reconciliations of non-GAAP disclosures used in this table to the comparable GAAP measures are provided in the accompanying table. Management, as well as regulators, financial analysts and other investors may use these measures in conjunction with more traditional bank capital ratios to compare the capital adequacy of banking organizations with significant amounts of goodwill or other intangible assets, which typically stem from the use of the purchase accounting method of accounting for mergers and acquisitions. These non-GAAP financial measures should not be considered in isolation or as a substitute for total shareholders’ equity, total assets, book value per share, return on average assets, return on average equity, or any other measure calculated in accordance with GAAP. Moreover, the manner in which we calculate these non-GAAP financial measures may differ from that of other companies reporting measures with similar names. |
Reconciliation of common shareholders' equity to tangible common equity |
|
September 30, 2022 |
|
|
September 30, 2021 |
|
Shareholders' equity |
|
$ |
73,820 |
|
|
$ |
116,144 |
|
Less goodwill and other intangibles |
|
|
28,616 |
|
|
|
29,151 |
|
Tangible common equity |
|
$ |
45,204 |
|
|
$ |
86,993 |
|
Average shareholders' equity |
|
$ |
98,637 |
|
|
$ |
114,244 |
|
Less average goodwill and other intangibles |
|
|
29,057 |
|
|
|
29,199 |
|
Average tangible common equity |
|
$ |
69,580 |
|
|
$ |
85,045 |
|
|
|
|
|
|
|
|
|
|
Tangible Book Value per Common Share |
|
|
|
|
|
|
|
|
Tangible common equity (a) |
|
$ |
45,204 |
|
|
$ |
86,993 |
|
Total common shares issued and outstanding (b) |
|
|
3,269,647 |
|
|
|
3,275,430 |
|
Tangible book value per common share (a)/(b) |
|
$ |
13.83 |
|
|
$ |
26.56 |
|
|
|
|
|
|
|
|
|
|
Return on Average Tangible Equity |
|
|
|
|
|
|
|
|
Year-to-date net income, annualized ( c ) |
|
$ |
10,368 |
|
|
$ |
14,484 |
|
Average tangible common equity (d) |
|
$ |
69,580 |
|
|
$ |
85,045 |
|
Return on average tangible common equity (c/d) |
|
|
14.90 |
% |
|
|
17.03 |
% |
|
|
|
|
|
|
|
|
|
Net Interest Margin, Tax- Equivalent |
|
|
|
|
|
|
|
|
Year-to-date net interest income, annualized |
|
$ |
34,951 |
|
|
$ |
35,989 |
|
Tax-equivalent adjustment |
|
|
984 |
|
|
|
745 |
|
Tax-equivalent net interest income, annualized (e) |
|
$ |
35,935 |
|
|
$ |
36,735 |
|
Average earning assets (f) |
|
$ |
983,763 |
|
|
$ |
957,815 |
|
Net interest margin, tax equivalent (e)/(f) |
|
|
3.65 |
% |
|
|
3.84 |
% |
|
|
|
|
|
|
|
|
|
Efficiency Ratio, Tax-Equivalent |
|
|
|
|
|
|
|
|
Year-to-date non-interest expense, annualized (g) |
|
$ |
34,436 |
|
|
$ |
37,145 |
|
Year-to-date tax-equivalent net interest income, annualized |
|
|
35,935 |
|
|
|
36,735 |
|
Year-to-date non-interest income, annualized |
|
|
10,839 |
|
|
|
18,973 |
|
Year-to-date total revenue, annualized (h) |
|
$ |
46,773 |
|
|
$ |
55,708 |
|
Efficiency ratio (g)/(h) |
|
|
73.62 |
% |
|
|
66.68 |
% |
Forward-Looking Statements
When used in this document, the words or phrases "will likely result," "are expected to," "will continue," "is anticipated," "estimated," "projected" or similar expressions are intended to identify "forward looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, which statements are subject to numerous assumptions, risks, and uncertainties. Actual results could differ materially from those contained or implied by such statements for a variety of factors, including: changes in economic conditions; movements in interest rates; competitive pressures on product pricing and services; success and timing of business strategies; the nature, extent, and timing of government actions and reforms; and extended disruption of vital infrastructure and the impact of the COVID-19 pandemic. Significant progress has been made to combat the outbreak of COVID-19, and while it appears that the epidemiological and macroeconomic conditions are trending in a positive direction as of September 30, 2022, if there is a resurgence in the virus, United Bancshares, Inc. (the "Corporation") could experience further adverse effects on its business, financial condition, results of operations and cash flows.
The Corporation cautions readers not to place undue reliance on any such forward looking statements, which speak only as of the date made. The Corporation does not undertake, and specifically disclaims any obligation, to update any forward looking statements to reflect occurrences or unanticipated events or circumstances after the date of such statements.
Introduction
The Corporation is a registered financial holding company incorporated under Ohio law and is subject to regulation by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”). The Corporation was incorporated and organized in 1985. The executive offices of the Corporation are located at 105 Progressive Drive, Columbus Grove, Ohio 45830. The Corporation is a one-bank holding company, as that term is defined by the Federal Reserve Board.
The Union Bank Company (the “Bank”), a wholly-owned subsidiary of the Corporation, is a full service community bank offering a full range of commercial and consumer banking services. The Bank is an Ohio state-chartered bank, which serves Allen, Delaware, Franklin, Hancock, Huron, Marion, Paulding, Putnam, Sandusky, Van Wert and Wood counties in Ohio, with office locations in Bowling Green, Columbus Grove, Delaware, Delphos, Findlay, Gahanna, Gibsonburg, Kalida, Leipsic, Lima, Marion, Ottawa, Paulding, Pemberville, Plymouth, Westerville and Worthington, Ohio.
Deposit services include checking accounts, savings and money market accounts; certificates of deposit and individual retirement accounts. Additional supportive services include online banking, bill pay, mobile banking, Zelle payment service, ATM’s and safe deposit box rentals. Treasury management and remote deposit capture products are also available to commercial deposit customers. Deposits of Union Bank are insured up to applicable limits by the Deposit Insurance Fund, which is administered by the Federal Deposit Insurance Corporation.
Loan products offered include commercial and residential real estate loans, agricultural loans, commercial and industrial loans, home equity loans, various types of consumer loans, and small business administration and USDA backed loans. Union Bank’s residential loan activities consist primarily of loans for purchasing or refinancing personal residences. The majority of these loans are sold to the secondary market.
Wealth management services are offered by Union Bank through an arrangement with LPL Financial LLC, a registered broker/dealer. Licensed representatives offer a full range of investment services and products, including financial needs analysis, mutual funds, securities trading, annuities and life insurance.
Union Bank has two subsidiaries: UBC Investments, Inc. (“UBC”), an entity formed to hold its securities portfolio, and UBC Property, Inc. (“UBC Property”), an entity formed to hold and manage certain property that is acquired in lieu of foreclosure.
UBC Risk Management, Inc. is a subsidiary of the Corporation and is located in Las Vegas, Nevada. It is a captive insurance subsidiary which insures various liability and property damage policies for the Corporation and its related subsidiaries.
The Corporation is registered as a Securities Exchange Act of 1934 reporting company, however the Corporation filed a Form 25 with the SEC to remove its common stock from listing on the NASDAQ Capital Market and to deregister its stock under Section 12(b) of the Exchange Act on August 17, 2022. The last trading day of its shares of common stock on the NASDAQ Capital Market was August 26, 2022. As of August 29, 2022, the corporation's shares commenced trading on the OTCQX Market under the symbol "UBOH". The Corporation filed a Form 15 with the SEC on September 1, 2022, to terminate the registration of its common stock under section 12(g) of the Exchange Act. Once the termination is effective, which is expected to occur within 90 days of filing, the Company’s obligation to file proxy materials and comply with Section 16 Exchange Act beneficial ownership reporting rules will end.
The obligation of the Corporation to file periodic reports with the SEC, including reports on Forms 10-K, 10-Q and 8-K, pursuant to Section 15(d) of the Exchange Act, will continue for the balance of its fiscal year ending December 31, 2022. The Corporation intends to file a Form 15 with the SEC after the filing of its Annual Report on SEC form 10-K for its fiscal year ended December 31, 2022, filed in early 2023, and upon such filing the Company’s obligation to file reports under Section 15(d) of the Exchange Act, including SEC Form 10-K, 10-Q, and 8-K, will be suspended immediately.
The following discussion and analysis of the consolidated financial statements of the Corporation is presented to provide insight into management’s assessment of the financial results.
Economic Environment
Growth in the U.S. economy has slowed in 2022, compared to the higher rates of growth experienced in 2021, as pressures from higher inflation and rising energy prices as well as concerns over the Russia-Ukraine war and the continued economic uncertainty caused by the COVID-19 pandemic resulted in U.S. Gross Domestic Product ("GDP") that shrank slightly in the first half of 2022, before rebounding somewhat in the third quarter. Despite the FRB's efforts to control inflation by raising short-term interest rates, it remains elevated, reflecting supply and demand imbalances related to the pandemic and higher energy prices as well as other broader price pressures, and exceeded an annual rate of 8.2% in the first nine months of 2022, well above the FRB's target inflation rate. In addition, the Russia-Ukraine war and related events are likely to create additional upward pressure on inflation and weigh on economic activity. Other geo-political pressures and mid-term elections continue to play a part in the uncertain economic conditions through the end of the year. Despite the fact that GDP declined slightly in the first and second quarters, before recovering slightly in the third quarter of 2022, the total unemployment rate has remained low, and is 3.5 percent at September 2022 compared with 3.9 percent at December 2021. The FRB has increased short-term interest rates by 300 basis points year-to-date in 2022 and indicated that ongoing increases in short-term interest rates will continue in the last quarter of 2022 and early in 2023 to control the rate of inflation.
As a result of these uncertainties, our credit administration continues to closely monitor and analyze the higher risk segments within the loan portfolio, tracking loan payment deferrals, customer liquidity and providing timely reports to senior management and the board of directors. Based on the Corporation's capital levels, prudent underwriting policies, loan concentration diversification and our geographic footprint, we are cautiously optimistic that the Corporation is positioned to continue managing the impact of the varied set of risks and uncertainties currently impacting our customer base and local economies. While we remain adequately capitalized, with strong levels of loan loss provisions, the Corporation may be required to make additional loan loss provisions as warranted by the extremely fluid global economic condition.
RESULTS OF OPERATIONS
Overview of the Income Statement
For the quarter ended September 30, 2022, the Corporation reported net income of $3,086,000, or $0.94 basic earnings per share, a decrease of $1,006,000 (24.6%) compared to the third quarter of 2021 net income of $4,092,000, or $1.25 basic earnings per share. The decrease in operating results for the third quarter of 2022 as compared to the same period in 2021 was primarily attributable to a decrease in non-interest income of $1,889,000 (40.1%) and a decrease in net interest income of $574,000 (5.8%), offset by a decrease in non-interest expenses of $815,000 (8.4%), and a decrease in the provision for income taxes of $642,000 (76.2%). The third quarter results include a $793,000, or $0.24 basic earnings per share, increase in non-interest income due to a BOLI death benefit payment.
Net income for the nine months ended September 30, 2022 totaled $7,776,000, or $2.37 basic earnings per share, compared to $10,863,000, or $3.31 basic earnings per share for the same period in 2021, a decrease of $3,087,000 (28.4%). The decrease in operating results for the nine month period ended September 30, 2022 as compared to the nine month period ended September 30, 2021 was primarily attributable to a decrease in net interest income of $779,000 (2.9%) and a decrease in non-interest income of $6,101,000 (42.9%), offset by a decrease in non-interest expenses of $2,032,000 (7.3%), a decrease in the provision for loan losses of $300,000, and a decrease in the provision for income taxes of $1,461,000 (66.4%).
Net Interest Income
Net interest income is the amount by which income from interest-earning assets exceeds interest incurred on interest-bearing liabilities. Interest-earning assets consist principally of loans and investment securities while interest-bearing liabilities include interest-bearing deposit accounts and borrowed funds. Net interest income remains the primary source of revenue for the Corporation. Changes in market interest rates, as well as changes in the mix and volume of interest-bearing assets and interest-bearing liabilities impact net interest income. Net interest income was $9,329,000 for the third quarter of 2022, compared to $9,903,000 for the same period of 2021, a decrease of $574,000 (5.8%). Net interest income was $26,213,000 for the nine months ended September 30, 2022 compared to $26,992,000 for the same period of 2021, a decrease of $779,000 (2.9%).
The decrease of $574,000 in net interest income for the quarter ended September 30, 2022 is attributable to a decrease in interest income of $522,000 (4.9%) and a $52,000 (7.0%) decrease in interest expense. The decrease of $779,000 in net interest income for the nine months ended September 30, 2022 was due to a decrease in interest income of $1,242,000 (4.2%), offset by a decrease of interest expense of $463,000 (19.3%).
The $522,000 decrease in interest income for the three months ended September 30, 2022 was a result of a $1,286,000 (13.8%) decrease in loan interest income, partially offset by an increase in investment portfolio income of $525,000 and an increase in other interest income of $239,000. The reduction in loan interest income was due to a $2,238,000 reduction in the loan fee income generated through PPP loans offset by an increase of $952,000 in loan interest income from higher volumes. The increase in the investment portfolio income was due to increased volumes when compared to the previous year and the increase in other interest income was due to higher interest earned on balances at the Federal Reserve.
Interest income decreased $1,242,000 for the nine months ended September 30, 2022. Loan interest income decreased $3,232,000, due primarily to a reduction in PPP loan fees of $3,722,000, offset by an increase of $490,000 in interest income from rising portfolio rates and volumes. Investment portfolio income increased $1,622,000 due to increased volumes, and other interest income increased $368,000 due to higher interest earned on balances at the Federal Reserve.
The yield on average earning assets was 3.91% for the nine months ended September 30, 2022 compared to 4.17% for the same period of 2021. This is due to the decrease in PPP and mortgage origination fees and a shifting mix of earning assets. The average interest-bearing cash, securities, and loan balances were $52.9 million, $300.8 million and $630.0 million for the nine months ended September 30, 2022, respectively compared to $97.4 million, $219.8 million and $640.6 million for the nine months ended September 30, 2021, respectively. The average loan balance decreased $10.6 million between the periods as a result of the average balance of PPP loans decreasing $64.7 million between the periods, offset by $54.1 million in new loan growth.
Interest expense increased $52,000 for the three months ended September 30, 2022, and decreased $463,000 for the nine months ended September 30, 2022 compared to the same periods in 2021. Interest expense increased in the third quarter of 2022 due to the increase in interest rates increasing the cost of funds to 0.42% for the third quarter of 2022 compared to 0.40% in the third quarter of 2021. Year-to-date deposit expense has decreased as the year-to-date average balance of higher yielding time deposits decreased $42.9 million, while lower yielding non-maturity deposit accounts increased $101.9 million. This lowered the cost of funds for the nine months ended September 30, 2022 to 0.34% compared to 0.44% for the same period of 2021. Management expects the cost of funds to increase through the remainder of 2022 and 2023 as deposit offering rates for non-maturity and time deposits have increased with the market and competition.
Net interest margin is calculated by dividing net interest income (adjusted to reflect tax-exempt interest income on a taxable equivalent basis) by average interest-earning assets. The resulting percentage serves as a measurement for the Corporation in comparing its results with those of past periods as well as those of peer institutions. For the quarter and nine months ended September 30, 2022 the net interest margin (on a taxable equivalent basis) was 3.91% and 3.65% compared with 4.12% and 3.84% for the same periods in 2021. This decrease can largely be attributed to PPP fee collected in the comparable periods in 2021. Loans comprised 66.9% of interest-earning assets at September 30, 2022 compared to 61.0% of interest-earning assets at September 30, 2021. Interest-bearing deposits comprised 97.5% of interest-bearing liabilities at September 30, 2022, compared to 97.2% for the same period in 2021.
Provision for Loan Losses
The Corporation’s provision for loan losses is determined based upon management’s calculation of the allowance for loan losses and is reflective of management’s assessment of the quality of the portfolio and overall management of the inherent credit risk of the loan portfolio. Changes in the provision for loan losses are dependent, among other things, on loan delinquencies, collateral position, portfolio risks and general economic conditions in the Corporation’s lending markets. In assessing the adequacy of the allowance, management considers the size and quality of the loan portfolio measured against prevailing economic conditions, regulatory guidelines, and historical loan loss experience. However, there is no assurance that loan credit losses will not exceed the allowance, and any growth in the loan portfolio and the uncertainty of the general economy may require additional provisions in future periods.
Due to a general stabilization of uncertainties related to COVID-19 in the regional and broader U.S. economy, as well as the current status of the Bank's loan portfolio, there was no provision for loan losses recognized during the nine-month period ended September 30, 2022, compared to a $300,000 provision for the nine months ended September 30, 2021. The allowance for loan losses at September 30, 2022 is 1.63% of total loans compared to 1.75% of total loans at September 30, 2021.
There is a possibility that the provision for loan losses could further increase in future periods based on the significant potential for the credit quality of our loan portfolio to decline and loan defaults to increase as a result of economic conditions. See “Allowance for Loan Losses” under Financial Condition for further discussion relating to the provision for loan losses.
Non-Interest Income
The Corporation’s non-interest income is largely generated from activities related to the origination, servicing and gain on sales of fixed rate mortgage loans; customer deposit account fees; earnings on life insurance policies; income arising from sales of investment products to customers; and occasional security sale transactions. Income related to customer deposit accounts and life insurance policies provides a relatively steady flow of income while the other sources are more volume or transaction related and consequently can vary from quarter to quarter.
For the quarter ended September 30, 2022, non-interest income was $2,823,000, compared to $4,712,000 for the third quarter of 2021, a decrease of $1,889,000. The decrease was primarily attributable to a decrease in gain on sales of loans of $2,947,000 (77.6%), offset by an increase in other non-interest income of $1,092,000 (119.1%).
Non-interest income for the nine months ended September 30, 2022 totaled $8,129,000, compared to $14,230,000 for the same period in 2021, a decrease of $6,101,000. The decrease in non-interest income was primarily attributable to decreases in gain on sales of loans of $9,722,000 (86.4%), offset by an increase in other non-interest income of $3,730,000 (125.2%).
The significant decrease in gain on sale of loans was attributable to a decrease in loan activity by the residential mortgage operations, along with a decrease in the net gain on sale, expressed as a percentage of loan balances sold. During the quarter ended September 30, 2022, there were 158 loans sold totaling $41.666 million, compared to 328 loans sold totaling $90.4 million during the same period of 2021. The net gain on sale was 1.77% for the third quarter of 2022 compared to 4.06% for the same period of 2021. For the nine months ended September 30, 2022, there were 541 loans sold totaling $148.7 million at a net gain on sale of 0.79% compared to the same period of 2021 when there were 1,098 loans sold totaling $286.9 million at a net gain on sale of 3.76%.
The increases in other non-interest income of $1,092,000 for the quarter ended September 30, 2022 and $3,730,000 year-to-date are both primarily due to increases in income from the Corporation’s loan hedging program and a $793,000 increase in BOLI income due to a death benefit payment.
Non-Interest Expenses
For the quarter ended September 30, 2022, non-interest expenses were $8,865,000, compared to $9,680,000 for the comparable quarter of 2021, a $815,000 decrease. The significant quarter-over-quarter decreases include salaries and benefits of $604,000 (11.2%), a result of lower mortgage loan commissions, loan origination expenses of $219,000 (46.8%), data processing expense of $125,000 (21.2%), and advertising and promotional expense of $119,000 (21.1%), offset by increases in exam and auditing expense of $61,000 (42.3%), and legal fees of $58,000 (190.9%).
Non-interest expenses were $25,827,000 for the nine months ended September 30, 2022, compared to $27,859,000 for the same period in 2021, a decrease of $2,032,000. The decrease in non-interest expenses was primarily attributable to decreases in salaries and benefits of $1,480,000 (9.4%), a result of lower mortgage loan commissions, loan origination expenses of $486,000 (39.7%), advertising and promotional expense of $294,000 (17.8%), and data processing expense of $233,000 (13.6%) offset by increases in equipment service expense of $75,000 (8.7%), travel and entertainment expense of $92,000 (133.9%), ATM processing expense of $63,000 (10.1%), and Ohio franchise tax expense of $62,000 (10.6%).
Maintaining acceptable levels of non-interest expenses and operating efficiency are key performance indicators for the Corporation in its strategic initiatives. The financial services industry uses the efficiency ratio (total non-interest expense as a percentage of the aggregate of fully-tax equivalent net interest income and non-interest income) as one of the key indicators of performance. For the quarter ended September 30, 2022, the Corporation’s efficiency ratio was 71.42%, compared to 65.33% for the same period of 2021. For the nine months ended September 30, 2022, the Corporation's efficiency ratio was 73.62% compared to 66.68% for the same period of 2021. A lower efficiency ratio generally indicates that a bank is spending less to generate every dollar of income. The increase in the efficiency ratio between the quarter and year-to-date periods is due to the significant reduction in residential mortgage activity, which has reduced non-interest income at a faster pace than non-interest expenses.
Provision for Income Taxes
The provision for income taxes for the quarter ended September 30, 2022, was $201,000 (effective rate of 6.1%), compared to $843,000 (effective rate of 17.1%) for the comparable 2021 period. The provision for the nine-month period ended September 30, 2022 was $739,000 (effective rate of 8.7%) compared to $2,200,000 (effective rate of 16.8%) for the comparable 2021 period. The decrease in the effective tax rate is largely due to tax-exempt securities and the BOLI death benefit payment comprising 41.5% of pre-tax income year-to-date September 30, 2022, compared to 15.5% for the comparable period in 2021.
FINANCIAL CONDITION
Overview of Balance Sheet
Total assets amounted to $1.06 billion at September 30, 2022 compared to $1.08 billion at December 31, 2021, a decrease of $17.3 million (1.6%). The decrease in total assets was primarily the result of decreases of $26.2 million (34.8%) in cash and cash equivalents, and $32.2 million (10.5%) in securities available for sale, offset by a $27.9 million (4.6%) increase in loans, and $13.5 million increase in other assets (136.4%). Deposits totaled $960.8 million at September 30, 2022, compared to $930.4 million at December 31, 2021, an increase of $30.4 million (3.3%).
Shareholders’ equity decreased by $45.3 million (38.0%) from $119.1 million at December 31, 2021 to $73.8 million at September 30, 2022. This was the result of an increase in unrealized losses on available for sale securities, net of tax of $50.3 million and dividends paid of $2,067,000 offset by net income of $7,776,000. The increase in unrealized losses on available for sale securities from December 31, 2021 to September 30, 2022 was attributable to increasing long-term treasury yields. Net unrealized gains and losses on available for sale securities are reported as accumulated other comprehensive (loss) income in the consolidated balance sheets.
Cash and Cash Equivalents
Cash and cash equivalents totaled $49.0 million at September 30, 2022 and $75.2 million at December 31, 2021, including interest-bearing deposits in other banks of $35.5 million at September 30, 2022 and $63.5 million at December 31, 2021. Management believes the current level of cash and cash equivalents is sufficient to meet the Corporation’s present liquidity and performance needs especially considering the availability of other funding sources, as described below. Total cash and cash equivalents fluctuate on a daily basis due to transactions in process and corresponding liquidity sources and uses. Management believes the Corporation’s liquidity needs in the near term will be satisfied by the current level of cash and cash equivalents, readily available access to traditional and non-traditional funding sources, and the portions of the investment and loan portfolios that will mature within one year. These sources of funds should enable the Corporation to meet cash obligations and off-balance sheet commitments as they come due. In addition, the Corporation has access to various sources of additional borrowings by virtue of long-term assets that can be used as collateral for such borrowings.
Securities
Management monitors the earnings performance and liquidity of the securities portfolio on a regular basis through Asset/Liability Committee (ALCO) meetings. As a result, all securities, except FHLB stock, have been designated as available-for-sale and may be sold if needed for liquidity, asset-liability management or other reasons. Such securities are reported at fair value, with any net unrealized gains or losses reported as a separate component of shareholders’ equity, net of related incomes taxes.
The amortized cost and fair value of available-for-sale securities as of September 30, 2022 totaled $334.1 million and $275.5 million, respectively, resulting in net unrealized loss before tax of $58.6 million and a corresponding after-tax loss reflected in shareholders’ equity of$46.3 million. While the unrealized loss negatively impacts tangible book value, and is being monitored closely, the Corporation has significant sources of liquidity, mitigating the risk of having to sell available-for-sale securities and realizing a loss.
Loans
The Corporation’s primary lending areas are Northwestern, West Central, and Central Ohio. Gross loans totaled $637.4 million at September 30, 2022, compared to $609.6 million at December 31, 2021, an increase of $27.8 million (4.6%). As compared to December 31, 2021, commercial and multi-family real estate loans increased $33.1 million, residential 1-4 family real estate loans increased $11.3 million, commercial loans decreased $16.5 million, and consumer loans decreased $101,000. Loans originated through the PPP program are included in the Commercial segment and had an outstanding balance of $1.2 million as of September 30, 2022 and $6.6 million at December 31, 2021. Excluding the impact of PPP loans forgiven, loans increased $33.2 million at September 30, 2022 as compared to December 31, 2021.
There are also unrecognized financial instruments at September 30, 2022 and December 31, 2021 which relate to commitments to extend credit and letters of credit. The contract amount of such financial instruments approximated $207.0 million at September 30, 2022 and $198.7 million at December 31, 2021.
Loan demand has been moderate through the first nine months of 2022, and it is possible that uncertainties in economic conditions in our market areas may lead to reductions in the growth of our commercial and industrial loan, commercial real estate loan, residential real estate loan and consumer loan portfolios. The Corporation continues to source relationship-based clients in markets and geographies that we are familiar with and understand.
Allowance for Loan Losses
The following table presents a summary of activity in the allowance for loan losses for the nine-month periods ended September 30, 2022 and 2021:
|
|
(in thousands) |
|
|
|
Nine months ended September 30, |
|
|
|
2022 |
|
|
2021 |
|
Balance, beginning of period |
|
$ |
10,355 |
|
|
$ |
9,994 |
|
Provision for loan losses |
|
|
- |
|
|
|
300 |
|
Charge offs |
|
|
- |
|
|
|
(5 |
) |
Recoveries |
|
|
45 |
|
|
|
22 |
|
Net recoveries |
|
|
45 |
|
|
|
17 |
|
Balance, end of period |
|
$ |
10,400 |
|
|
$ |
10,311 |
|
The allowance for loan losses as a percentage of gross loans was 1.63% at September 30, 2022, 1.70% at December 31, 2021, and 1.75% at September 30, 2021. Excluding PPP loans and the related allocation of allowance, the allowance for loan losses as a percentage of gross loans was 1.63% at September 30, 2022, 1.72% at December 31, 2021, and 1.82% at September 30, 2021. Based on current economic indicators, the Corporation increased the economic factors within the allowance for loan losses evaluation.
Regular provisions are made in amounts sufficient to maintain the balance in the allowance for loan losses at a level considered by management to be adequate for losses within the portfolio. Even though management uses all available information to assess possible loan losses, future additions or reductions to the allowance may be required as changes occur in economic conditions and specific borrower circumstances. The regulatory agencies that periodically review the Corporation’s allowance for loan losses may also require additions to the allowance or the charge-off of specific loans based upon the information available to them at the time of their examinations.
Loans on non-accrual status amounted to $1,014,000 at September 30, 2022 and $320,000 at December 31, 2021. Non-accrual loans as a percentage of outstanding loans amounted to 0.16% at September 30, 2022 and 0.05% at December 31, 2021.
There were $524,000 in commercial loans over 90 days but still accruing at September 30, 2022. These loans were originated through the PPP program and are pending a determination of forgiveness from the SBA.
The Corporation considers a loan to be impaired when it becomes probable that the Corporation will be unable to collect under the contractual terms of the loan based on current information and events. The Corporation had impaired loans totaling $1,642,000 at September 30, 2022 and $1,948,000 at December 31, 2021
In addition to impaired loans the Corporation had other potential problem credits, consisting of loans graded substandard or special mention, as well as loans over 90 days past due, loans on non-accrual, and TDR loans, amounting to $10.3 million at September 30, 2022 and $24.7 million at December 31, 2021. The Corporation’s credit administration department continues to closely monitor these credits.
The Corporation provides pooled reserves for potential problem loans using loss rates calculated considering historic net loan charge-off experience, as well as other environmental and qualitative factors. The Corporation experienced no loan charge-offs during the first nine months of 2022 compared to $5,000 during the first nine months of 2021. The Corporation also provides pooled general reserves for the remaining portion of its loan portfolio not considered to be problem or potential problem loans. These general reserves are also calculated considering, among other things, the historic net charge-off experience for the related loan type.
Funding Sources
The Corporation considers a number of alternatives, including but not limited to, deposits, as well as short-term and long-term borrowings when evaluating funding sources. Deposits, including customer deposits, and public funds deposits continue to be the most significant source of funds for the Corporation, totaling $960.8 million, or 97.5% of the Corporation’s outstanding funding sources at September 30, 2022, compared to $930.4 million at December 31, 2021.
Non-interest bearing deposits comprised 22.6% of total deposits at
September 30, 2022 and 21.0% at
December 31, 2021.
In addition to traditional deposits, the Corporation maintains both short-term and long-term borrowing arrangements. Other borrowings consisted of $6,250,000 and $7,012,000 of a term borrowing from the United Bankers’ Bank (UBB) at September 30, 2022 and December 31, 2021, respectively. The Corporation also has outstanding junior subordinated deferrable interest debentures of $13,001,000 and $12,976,000 at September 30, 2022 and December 31, 2021, respectively. Management plans to maintain access to various borrowing alternatives as an appropriate funding source.
Regulatory Capital
The Corporation and Bank met all regulatory capital requirements as of September 30, 2022, and the Bank is considered “well capitalized” under regulatory and industry standards of risk-based capital.
Cash Flow from Operations
As part of the Bank's hedging program, loans held for sale are accumulated into larger blocks before being sold. Depending on the timing of the sales of these blocks, there could be a positive or negative impact to net income and cash flow from operations. As of September 30, 2022, loans held for sale amounted to $8,078,000 compared to $9,146,000 as of December 31, 2021 resulting in a positive impact to cash flow from operations for the nine month period ended September 30, 2022 of $1,068,000. There was a positive impact on cash flow from operations for the nine-month period ended September 30, 2021 of $3,882,000 from a decrease in loans held for sale. Excluding these changes in loans held for sale, cash flow from operations for the nine months ended September 30, 2022 and 2021 would have been a positive $10,275,000 and $18,610,000, respectively.
Liquidity and Interest Rate Sensitivity
The objective of the Corporation’s asset/liability management function is to maintain consistent growth in net interest income through management of the Corporation’s balance sheet liquidity and interest rate exposure based on changes in economic conditions, interest rate levels, and customer preferences.
The Corporation manages interest rate risk to minimize the impact of fluctuating interest rates on earnings. The Corporation uses simulation techniques that attempt to measure the volatility of changes in the level of interest rates, basic banking interest rate spreads, the shape of the yield curve, and the impact of changing product growth patterns. The primary method of measuring the sensitivity of earnings of changing market interest rates is to simulate expected cash flows using varying assumed interest rates while also adjusting the timing and magnitude of non-contractual deposit re-pricing to more accurately reflect anticipated pricing behavior. These simulations include adjustments for the lag in prime loan re-pricing and the spread and volume elasticity of interest-bearing deposit accounts, regular savings and money market deposit accounts.
The principal function of interest rate risk management is to maintain an appropriate relationship between those assets and liabilities that are sensitive to changing market interest rates. The Corporation closely monitors the sensitivity of its assets and liabilities on an ongoing basis and projects the effect of various interest rate changes on its net interest margin. Interest sensitive assets and liabilities are defined as those assets or liabilities that mature or re-price within a designated time frame.
Management believes the Corporation’s current mix of assets and liabilities provides a reasonable level of risk related to significant fluctuations in net interest income and the resulting volatility of the Corporation’s earning base. The Corporation’s management reviews interest rate risk in relation to its effect on net interest income, net interest margin, and the volatility of the earnings base of the Corporation.
Effects of Inflation on Financial Statements
All of the Corporation’s assets relate to commercial banking operations and are generally monetary in nature. Therefore, they are not impacted by inflation to the same degree as companies in capital-intensive industries in a replacement cost environment. During a period of rising prices, a net monetary asset position results in loss of purchasing power and conversely a net monetary liability position results in an increase in purchasing power. In the commercial banking industry, monetary assets typically exceed monetary liabilities. The Corporation has not experienced a significant level of inflation or deflation during the nine-month period ended September 30, 2022. Management continues to closely monitor interest rate sensitivity trends through the Corporation's asset liability management program and in calculating the allowance for loan losses.